Easy Money May Boost Economy But At What Cost?

Specialist David Pologruto works at his post on the floor of the New York Stock Exchange on Sept. 13, as Federal Reserve Chairman Ben Bernanke holds a news conference in Washington. The world's central banks are easing credit, putting more money into the global economy.

Richard Drew
/ AP

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Originally published on September 28, 2012 11:31 am

The world's central banks are pumping cash into their economies, pushing down interest rates in hopes the ready cash and lower rates will boost borrowing and economic activity. Everyone agrees the action is dramatic and unprecedented, but there's disagreement over whether they will do more harm than good.

Economists know very well the trillions of dollars being added by the central banks to the global economy can be risky.

"These are risks about long-term rises in inflation, housing bubbles potentially building up," says Jacob Kirkegaard of the Peterson Institute.

Those are the kinds of things that happen when too much money chases too few goods.

James McCaughan, head of Principal Global Investors, says one such response was obvious right after the Federal Reserve announced "QE3," its latest round of stimulus.

"One of the natural reactions was that the oil price went up," McCaughan says. "Now, that's not so good for most economic activity."

He says it's bad for consumers, businesses and job creation.

"It's a perverse effect of something that was intended to improve employment," he says.

But not everyone agrees with McCaughan's analysis, and oil prices have fallen again in the past week.

Harvard economist Ken Rogoff says given the sluggish global economy, he thinks the risk of inflation from too much central bank stimulus is small. And, he says, the potential rewards are worth that risk.

"Yes we don't want to be a banana republic where we have rampant runaway inflation, but make no mistake this is a very risky situation," he says. "The aftermath of the financial crises ... is long and ugly and it could be far from over."

It could take 10 to 20 years to recover fully from the crisis.Rogoff says the massive central bank injections of cash should be seen as an insurance policy against slipping back into recession. The thing that makes the road back so difficult, he says, is the large hangover of consumer and government debt.

Here's one way to think about what's happening: The central banks have filled a huge reservoir with cash; they actually call it liquidity. But it's not having the desired effect, Rogoff says.

"The pool is stagnant, and we're not getting healthy from one part of the economy to the other," he says.

That's because there's a huge dam blocking the flow into the economic river below. That dam is partly made of debt, says Noah Wilcox, president of Grand Rapids State Bank, a small bank in the logging and mining area of northeastern Minnesota.

Wilcox says the debt hangover is blocking the demand for consumer loans.

"You've got a lot of people who are underwater in the homes," he says. "They may want to buy new house or go buy a new car, or do something like that. But the problem is they are underwater, and they just want to sit tight, and that just depresses consumer loan demand."

Consumers are already underwater in debt. Why would they want another loan from the giant reservoir of money the central banks have created?

There are other reasons that central bank cash isn't turning into loans that could boost the economy. Uncertainty about the outcome of the election and the fiscal cliff has businesses paralyzed, Wilcox says. He also says the Fed has pushed rates so low it's much harder for banks to make a profit.

"It's definitely less profitable for us to make loans today," he says.

Indeed, the difference between the interest rate the bank pays the folks in Grand Rapids, Minn., for their deposits, and the rates it can charge for business and home and car loans has narrowed. That reduces the incentive for banks to lend, says Peter Fisher of the Wall Street financial firm BlackRock.

"How hard are the bankers going to work lending?" he says. "You can lower the interest rate by sort of engineering it down to kind of try to get the people downstream to borrow more. But if they're not interested in borrowing, I think you ought be trying to get the bankers to lend more."

If you keep pushing rates lower, Fisher says, you discourage lending. It's just not worth the risk of giving someone a loan if your return is too low. In fact, Fisher says he believes the most dangerous unintended consequence of the Fed's low rate policy is that instead of boosting lending and the flow of money through the economy, it's restricting the flow.

Copyright 2017 NPR. To see more, visit http://www.npr.org/.

DAVID GREENE, HOST:

Not that we needed any more proof, but the economy has been growing slowly. New figures from the Commerce Department show economic growth of just 1.3 percent in the second quarter - lower than expected.

STEVE INSKEEP, HOST:

Despite that slow growth in April, May and June, not to mention the weak job market, a survey of consumer confidence shows Americans getting more optimistic. A reviving housing market may be giving people a better outlook. But whatever they're thinking, the optimism is not necessarily shared by the Federal Reserve and other leading central banks.

GREENE: From the U.S. to Japan to Europe, central banks are pumping cash into their economies in what some call an unprecedented effort to push down interest rates and stimulate borrowing and investment. As NPR's John Ydstie reports, some fear these actions might do more harm than good.

JOHN YDSTIE, BYLINE: The amount of money central banks around the world are adding to the global economy is counted in the trillions of dollars. And economists like Jacob Kirkegaard of the Peterson Institute know very well that can be risky.

JACOB KIRKEGAARD: These are risks about long-term rises in inflation, housing bubbles potentially building up.

YDSTIE: The kind of thing that happens when you have too much money chasing too few goods. James McCaughan, head of Principal Global Investors, says one such response was obvious right after the Fed announced QE3, its latest round of stimulus.

JAMES MCCAUGHAN: One of the most natural reactions was that the oil price went up. Now, that's not so good for most economic activity.

MCCAUGHAN: It's a perverse effect of something that was intended to improve employment.

YDSTIE: But not everyone agrees with McCaughan's analysis, and in the past week, oil prices have fallen again. Harvard economist Ken Rogoff says given the sluggish global economy, he thinks the risk of inflation from too much central bank stimulus is very small. And, he says, the potential rewards are worth the risk.

KEN ROGOFF: Yes, we don't want to be a banana republic, where we have rampant, runaway inflation. But make no mistake: this is a very risky situation. The aftermath of financial crises - and Carmen Reinhart and I have studied 800 years of them - is long and ugly, and it could be far from over.

YDSTIE: Long and ugly, as in 10 to 20 years to recover fully. Rogoff says the massive central bank injections of cash should be seen as an insurance policy against slipping back into recession. The thing that makes the road back so difficult, says Rogoff, is the large hangover of consumer and government debt. Here's one way to think about what's happening: The central banks have filled a huge reservoir with cash. They actually call it liquidity. But it's not having the desired effect, says Rogoff.

ROGOFF: The pool is stagnant, and we're not getting a healthy from one part of the economy to the other.

YDSTIE: That's because there's a huge dam blocking the flow into the economic river below. And that dam is partly made of debt, says Noah Wilcox. He's president of a small bank in the logging and mining area of northeastern Minnesota, the Grand Rapids State Bank. Wilcox says the demand for consumer loans is being blocked by the debt hangover.

NOAH WILCOX: You've got a lot of people that are still underwater in their homes. They may want to buy new house or go buy a new car, or do something like that, but the problem is that they are underwater, and they're just going to sit tight, and that oppresses consumer loan demand.

YDSTIE: There's that water metaphor again: Consumers are already underwater in debt. Why would they want another loan from the giant reservoir of money the central banks have created? There are other reasons that central bank cash isn't turning into loans that could boost the economy. Uncertainty about the outcome of the election and the fiscal cliff has businesses paralyzed, says Wilcox. And he also says the Fed has pushed rates so low that it's much harder for banks to make a profit.

WILCOX: It's definitely less profitable for us to make loans today.

YDSTIE: That's because the difference between the interest rate the bank pays the folks in Grand Rapids for their deposits and the rates it can charge for business and home and car loans has narrowed. That reduces the incentive for banks to lend, says Peter Fisher of the Wall Street firm BlackRock.

PETER FISHER: How hard are the bankers going to work lending? You can lower the interest rate by sort of engineering it down to kind of try to get the people downstream to borrow more. But if they're not interested in borrowing, I think you ought to be trying to get the bankers to lend more.

YDSTIE: And if you keep pushing interest rates lower and lower, you discourage lending, says Fisher. It's just not worth the risk of giving someone a loan if your return is too low. In fact, Fisher believes the most dangerous unintended consequence of the Fed's low rate policy is that instead of boosting lending and the flow of money through the economy, it's restricting the flow. John Ydstie, NPR News, Washington. Transcript provided by NPR, Copyright NPR.